Discovery Communications, Inc. Annual Report 2018

Form 10-K (NASDAQ:DISCA)

Published: February 28th, 2018

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549

FORM 10-K

ý ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2017 OR ¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File Number: 001-34177

Discovery Communications, Inc. (Exact name of Registrant as specified in its charter)

Delaware 35-2333914 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.)

One Discovery Place Silver Spring, Maryland 20910 (Address of principal executive offices) (Zip Code)

(240) 662-2000 (Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class Name of Each Exchange on Which Registered Series A Common Stock, par value $0.01 per share The NASDAQ Global Select Market Series B Common Stock, par value $0.01 per share The NASDAQ Global Select Market Series C Common Stock, par value $0.01 per share The NASDAQ Global Select Market

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ý No ¨

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No ý

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes ý No ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ý Accelerated filer ¨

Smaller reporting Non-accelerated filer ¨ (Do not check if a smaller reporting company) company ¨

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý

The aggregate market value of voting and non-voting common stock held by non-affiliates of the Registrant computed by reference to the last sales price of such stock, as of the last business day of the Registrant’s most recently completed second fiscal quarter, which was June 30, 2017, was approximately $9 billion.

Total number of shares outstanding of each class of the Registrant’s common stock as of February 21, 2018 was:

Series A Common Stock, par value $0.01 per share 155,613,008 Series B Common Stock, par value $0.01 per share 6,512,379 Series C Common Stock, par value $0.01 per share 219,782,537

DOCUMENTS INCORPORATED BY REFERENCE

Certain information required in Item 10 through Item 14 of Part III of this Annual Report on Form 10-K is incorporated herein by reference to the Registrant’s definitive Proxy Statement for its 2018 Annual Meeting of Stockholders, which shall be filed with the Securities and Exchange Commission pursuant to Regulation 14A of the Securities Exchange Act of 1934, as amended, within 120 days of the Registrant’s fiscal year end.

DISCOVERY COMMUNICATIONS, INC. FORM 10-K TABLE OF CONTENTS

Page

PART I 4

ITEM 1. Business. 4

ITEM 1A. Risk Factors. 19

ITEM 1B. Unresolved Staff Comments. 29

ITEM 2. Properties. 29

ITEM 3. Legal Proceedings. 29

ITEM 4. Mine Safety Disclosures. 30

PART II 32

ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. 32

ITEM 6. Selected Financial Data. 35

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 37

ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk. 62

ITEM 8. Financial Statements and Supplementary Data. 68

ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. 150

ITEM 9A. Controls and Procedures. 150

ITEM 9B. Other Information. 150

PART III 150

ITEM 10. Directors, Executive Officers and Corporate Governance. 151

ITEM 11. Executive Compensation. 151

ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. 151

ITEM 13. Certain Relationships and Related Transactions, and Director Independence. 151

ITEM 14. Principal Accountant Fees and Services. 151

PART IV 152

ITEM 15. Exhibits and Financial Statement Schedules. 152 ITEM 16. Form 10-K Summary. 152

SIGNATURES 160

PART I

ITEM 1. Business. For convenience, the terms “Discovery,” the “Company,” “we,” “us” or “our” are used in this Annual Report on Form 10-K to refer to both Discovery Communications, Inc. and collectively to Discovery Communications, Inc. and one or more of its consolidated subsidiaries, unless the context otherwise requires. We were formed on September 17, 2008 as a Delaware corporation in connection with Discovery Holding Company (“DHC”) and Advance/Newhouse Programming Partnership (“Advance/Newhouse”) combining their respective ownership interests in Discovery Communications Holding, LLC (“DCH”) and exchanging those interests with and into Discovery (the “Discovery Formation”). As a result of the Discovery Formation, DHC and DCH became wholly-owned subsidiaries of Discovery, with Discovery becoming the successor reporting entity to DHC.

OVERVIEW We are a global IP media company that provides content around the world via linear platforms, including pay- television ("pay-TV"), free-to-air ("FTA") and broadcast television, as well as various digital distribution platforms, including ad-supported TV Everywhere ("TVE") offerings, subscription-based direct-to-consumer products, digital and mobile-first, social media platforms and over-the-top streaming services. We also enter into content licensing agreements. As one of the world’s largest pay-TV programmers, we provide original and purchased content and live events to more than 3 billion cumulative subscribers and viewers worldwide through networks that we wholly or partially own. We distribute customized content in the U.S. and approximately 220 other countries and territories in over 40 languages. Our global portfolio of networks includes prominent nonfiction television brands such as Discovery Channel, our most widely distributed global brand, TLC, Investigation Discovery, Animal Planet, Science and Velocity (known as Turbo outside of the U.S.). Our portfolio includes Eurosport, a leading sports entertainment provider and the Olympic Games (the "Olympics") across Europe, as well as Discovery Kids, a leading children's entertainment brand in Latin America. We participate in joint ventures including Group Nine Media ("Group Nine"), a digital media holding company home to top digital brands including NowThis News, The Dodo, Thrillist and Seeker, as well as The Enthusiast Network ("TEN"), a leading digital media company for auto fans which includes our Velocity network and Motor Trend On Demand. We operate a portfolio of additional websites, digital direct-to-consumer products, a production studio and curriculum-based education products and services. Our objectives are to invest in high-quality content for our networks and brands to build viewership, optimize distribution revenue, capture advertising sales, and create or reposition branded channels and businesses to sustain long-term growth and occupy a desired content niche with strong consumer appeal. Our strategy is to maximize the distribution, ratings and profit potential of each of our branded networks. In addition to growing distribution and advertising revenues for our branded networks, we are extending content distribution across new platforms, including brand-aligned websites, online streaming, mobile devices, video on demand ("VOD") and broadband channels, which provide promotional platforms for our television content and serve as additional outlets for advertising and distribution revenue. Audience ratings are a key driver in generating advertising revenue and creating demand on the part of cable television operators, direct-to-home ("DTH") satellite operators, telecommunication service providers, and other content distributors who deliver our content to their customers. Our content spans genres including survival, exploration, sports, lifestyle, automobiles, general entertainment, heroes, adventure, crime and investigation, health and kids. We have an extensive library of high-definition content and own rights to the majority of our content and footage, which enables us to exploit our library to launch brands and services into new markets quickly. Our content can be re-edited and updated in a cost-effective manner to provide topical versions of subject matter that can be utilized around the world on a variety of platforms. Although the Company utilizes certain brands and content globally, we classify our operations in two reportable segments: U.S. Networks, consisting principally of domestic television network brands, and International Networks, consisting primarily of international television network brands. In addition, Education and Other consists principally of curriculum-based product and service offerings and a production studio. Our segment presentation aligns with our management structure and the financial information management has used to make strategic and operating decisions, such as the allocation of resources and business performance assessments. Financial information for our segments and the geographical areas in which we do business is set forth in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 21 to the consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. Our global brands are described below.

ANTICIPATED ACQUISITION

Scripps Networks Interactive, Inc. ("Scripps Networks" ) On February 26, 2018, the U.S. Department of Justice notified the Company that it has closed its investigation into Discovery's agreement for a plan of merger (the "Merger Agreement") to acquire Scripps Networks in a cash-and- stock transaction (the "Scripps Networks acquisition"). Scripps Networks is a global media company with lifestyle- oriented content, such as home, food, and travel-related programming. The Scripps Networks portfolio of networks includes HGTV, Food Network, Travel Channel, DIY Network, Cooking Channel and Great American Country, and TVN S.A.’s (“TVN”) portfolio of networks outside the United States. Additionally, outside the United States, Scripps Networks participates in UKTV, a joint venture with BBC Worldwide Limited (the “BBC”). The estimated merger consideration for the acquisition totals $12.0 billion, including $8.4 billion of cash and $3.6 billion of our Series C common stock based on our Series C common stock prices as of January 31, 2018. In addition, the Company will assume approximately $2.7 billion of Scripps Networks' net debt. The transaction is expected to close in early 2018. Scripps Networks shareholders will receive $63.00 per share in cash and a number of shares of Discovery's Series C common stock that is determined in accordance with a formula and subject to a collar based on the volume weighted average price of the Company's Series C common stock. The formula is based on the volume weighted average price of Discovery's Series C common stock over the 15 trading days ending on the third trading day prior to closing (the “Average Discovery Price”). Scripps Networks shareholders will receive 1.2096 shares of Discovery's Series C common stock if the Average Discovery Price is below $22.32, and 0.9408 shares of Discovery's Series C common stock if the Average Discovery Price is above $28.70. The intent of the range was to provide Scripps Networks shareholders with $27.00 of value per share in Discovery Series C common stock; if the Average Discovery Price is greater than or equal to $22.32 but less than or equal to $28.70, Scripps Networks shareholders will receive a proportional number of shares between 1.2096 and 0.9408. If the Average Discovery Price is below $25.51, Discovery has the option to pay additional cash instead of issuing more shares above the 1.0584 conversation ratio required at $25.51. The cash payment is equal to the product of the additional shares required under the collar formula multiplied by the Average Discovery Price; for example, if the Average Discovery Price were $22.32 with a conversion ratio of 1.2096, the Company could offer shares at the 1.0584 ratio and pay for the difference associated with the incremental shares in cash. Outstanding employee equity awards or share-based awards that vest upon the change of control will be acquired with a similar combination of cash and shares of Discovery Series C common stock pursuant to terms specified in the Merger Agreement. Therefore, the merger consideration will fluctuate based upon changes in the share price of Discovery Series C common stock and the number of Scripps Networks common shares, stock options, and other equity-based awards outstanding on the closing date. Discovery will also pay certain transaction costs incurred by Scripps Networks. The post-closing impact of the formula was intended to result in Scripps Networks’ shareholders owning approximately 20% of Discovery’s fully diluted common shares and Discovery’s shareholders owning approximately 80%. The Company will utilize the proceeds of the senior notes offering described below, borrowings under certain term loans (see Note 9 to the accompanying consolidated financial statements) and cash on hand to finance the cash portion of the transaction. The transaction is subject to regulatory approvals and other customary closing conditions. John C. Malone, Advance/Newhouse and members of the Scripps family entered into voting agreements to vote in favor of the transactions (the “Advance/Newhouse Voting Agreement”) and the stockholders of both Discovery and Scripps Networks approved the transaction on November 17, 2017. In addition, Advance/Newhouse has provided its consent, in its capacity as the holder of Discovery’s outstanding shares of Series A preferred stock, for Discovery to enter into the Merger Agreement and consummate the merger. In connection with this consent, Discovery and Advance/Newhouse entered into an exchange agreement pursuant to which Advance/Newhouse exchanged all of its shares of Series A and Series C preferred stock of Discovery for shares of newly designated Series A-1 and Series C-1 preferred stock of Discovery. The exchange transaction did not change the aggregate number of shares of Discovery’s Series A common stock and Series C common stock that are beneficially owned by Advance/Newhouse or change voting rights or liquidation preferences afforded to Advance/Newhouse. Discovery valued the securities immediately prior to and immediately after the exchange and determined that the exchange increased the fair value of Advance/Newhouse’s preferred stock by $35 million. Discovery does not believe the exchange is considered significant and does not reflect an extinguishment of the previously issued preferred stock for accounting purposes. Accordingly, Discovery has accounted for the exchange of the previously issued preferred stock as a modification, which is measured as the increase in fair value of the preferred stock held by Advance/Newhouse. The impact of the modification has been recorded as a component of selling, general and administrative expense. (See Note 3 and Note 12 to the accompanying consolidated financial statements). All of Discovery's direct costs of the Scripps Networks acquisition will be reflected as a component of selling, general and administrative expense in the consolidated statements of operations. On September 21, 2017, Discovery Communications, LLC ("DCL") issued a series of senior notes to partially fund the acquisition of Scripps Networks with an aggregate principal amount of $6.8 billion. With the exception of $900 million in senior notes that mature in 2019, the senior notes contain a special mandatory redemption feature requiring the Company to redeem the notes for a price equal to 101% of the principal amount plus any accrued and unpaid interest on the senior notes in the event that the Scripps Networks acquisition has not closed on or prior to August 30, 2018, or if the Merger Agreement is terminated prior to that date. While the Company expects to complete the acquisition on or before the deadline, unanticipated developments could delay or prevent the acquisition. As such, the Company cannot ensure that it will complete the acquisition by August 30, 2018. (See Note 3 to the accompanying consolidated financial statements).

Global Network Brands Subscriber statistics set forth in this Annual Report on Form 10-K include both wholly-owned networks and networks operated by equity method investees. Domestic subscriber statistics are based on Nielsen Media Research. International subscriber and viewer statistics are derived from internal data coupled with external sources when available. As used herein, a “subscriber” is a single household that receives the applicable network from its cable television operator, DTH satellite operator, telecommunication service provider, or other television provider, including those who receive our networks from pay-TV providers without charge pursuant to various pricing plans that include free periods and/or free carriage. The term “cumulative subscribers” refers to the sum of the total number of subscribers to each of our networks or content services. By way of example, two households that each receive five of our networks from their pay-TV provider represent two subscribers, but 10 cumulative subscribers. The term "viewer" is a single household that receives the signal from one of our networks using the appropriate receiving equipment without a subscription to a pay-TV provider. Our global brands are the following:

• Discovery Channel reached approximately 91 million subscribers in the U.S. and 6 million subscribers through a licensing arrangement with partners in Canada included in the U.S. Networks segment as of December 31, 2017. Discovery Channel reached approximately 340 million subscribers in international markets as of December 31, 2017 including the Discovery HD Showcase brand. • Discovery Channel is dedicated to creating the highest quality non-fiction content that informs and entertains its consumers about the world in all its wonder, diversity and amazement. The network offers a signature mix of high-end production values and vivid cinematography across genres including science and technology, exploration, adventure, history and in-depth, behind-the-scenes glimpses at the people, places and organizations that shape and share our world. • Discovery Channel content includes Gold Rush, Naked and Afraid , Deadliest Catch, Fast N' Loud, Street Outlaws, Alaskan Bush People, Manhunt: UNABOMBER, and recently, the return of Cash Cab. Discovery Channel is also home to Shark Week, the network's long-running annual summer TV event. • Target viewers are adults aged 25-54, particularly men.

• TLC reached approximately 89 million subscribers in the U.S. as of December 31, 2017, and also reached 9 million subscribers in Canada that are included in the U.S. Networks segment as of December 31, 2017. TLC content reached approximately 375 million subscribers in international markets as of December 31, 2017 including the Home & Health, Real Time and Travel & Living brands. • TLC celebrates remarkable real-life stories without judgment, programming genres that include fascinating families, heartwarming transformations and life's milestone moments. • Content on TLC includes the 90 Day Fiancé franchise, Little People, Big World, Long Island Medium, Outdaughtered and returning in 2018, Trading Spaces. • Target viewers are adults aged 25-54, particularly women.

• Animal Planet reached approximately 87 million subscribers in the U.S. and 2 million subscribers through a licensing arrangement with partners in Canada included in the U.S. Networks segment as of December 31, 2017. Animal Planet reached approximately 263 million subscribers in international markets as of December 31, 2017. • Animal Planet immerses viewers in the full range of life in the animal kingdom with rich, deep content via multiple platforms, offering animal lovers access to a centralized, television, digital social and mobile community for immersive, engaging, high-quality entertainment, information and enrichment. • Content on Animal Planet includes River Monsters, Tanked, Pit Bulls & Parolees, The Zoo, Dr. Jeff: Rocky Mountain Vet, Treehouse Masters and Puppy Bowl. • Target viewers are adults aged 25-54. • Investigation Discovery ("ID") reached approximately 84 million subscribers in the U.S. and 1 million subscribers through a licensing arrangement with partners in Canada included in the U.S. Networks segment as of December 31, 2017. ID reached approximately 167 million subscribers in international markets as of December 31, 2017. • ID is a leading mystery and suspense network. From harrowing crimes and salacious scandals to the in-depth investigation and heart-breaking mysteries behind these "real people, real stories," ID challenges our everyday understanding of culture, society and the human condition. • ID content includes the American Murder Mystery franchise, Homicide Hunter: Lt. Joe Kenda, People Magazine Investigates, Deadline: Crime with Tamron Hall and On The Case With Paula Zahn. • Target viewers are adults aged 25-54, particularly women.

• Science Channel reached approximately 65 million subscribers in the U.S. and 2 million subscribers through a licensing arrangement with partners in Canada included in the U.S. Networks segment as of December 31, 2017. Science Channel reached approximately 117 million subscribers in international markets as of December 31, 2017. • Science Channel is home to all things science around the clock. Science Channel is the premiere TV, digital and social community for those with a passion for science, space, technology, archeology, and engineering. • Content on Science Channel includes MythBusters, Street Science, Outrageous Acts of Science, What on Earth?, How the Universe Works and How It's Made. • Target viewers are adults aged 25-54.

• Velocity reached approximately 73 million subscribers in the U.S. as of December 31, 2017. Velocity reached approximately 114 million subscribers in international markets, where the brand is known as Turbo, as of December 31, 2017. • Velocity engages viewers with a variety of high-octane, action-packed, intelligent thrilling automotive programming. In addition to series and specials exemplifying the very best of the automotive genre, the network broadcasts approximately 100 hours of live event coverage every year. • Content on Velocity includes Wheeler Dealers, Texas Metal, Iron Resurrection and Barrett-Jackson Live. • In 2017, Discovery formed a joint venture ("VTEN") with Velocity and TEN to create a leading automotive digital media company comprised of consumer automotive brands including Motor Trend, Hot Rod, Automobile, and more. Motor Trend On Demand, which is part of the transaction and is being enhanced with Velocity content, represents the Company's first direct-to-consumer opportunity in the U.S. Discovery has a 67.5% ownership interest in the new joint venture. The joint venture is controlled and consolidated by Discovery. (See Note 3 to the accompanying consolidated financial statements.) • Target viewers are adults aged 25-54, particularly men.

U.S. NETWORKS U.S. Networks generated revenues of $3.4 billion and adjusted operating income before depreciation and amortization ("Adjusted OIBDA") of $2.0 billion during 2017, which represented 50% and 80% of our total consolidated revenues and Adjusted OIBDA, respectively. Our U.S. Networks segment owns and operates 11 national television networks, including fully distributed television networks such as Discovery Channel, TLC and Animal Planet. U.S. Networks generates revenues from fees charged to distributors of our television networks’ first run content, which include cable, DTH satellite and telecommunication service providers, referred to as affiliate fees; fees from distributors for licensed content and content to equity method investee networks, referred to as other distribution revenue; fees from advertising sold on our television networks and digital products, which includes our GO suite of TVE applications and our virtual reality product, Discovery VR; fees from providing sales representation, network distribution services; and revenue from licensing our brands for consumer products. During 2017, distribution, advertising and other revenues were 47%, 51% and 2%, respectively, of total net revenues for this segment. Typically, our television networks are aired pursuant to multi-year carriage agreements that provide for the level of carriage that our networks will receive and for annual graduated rate increases. Carriage of our networks depends on package inclusion, such as whether networks are on the more widely distributed, broader packages or lesser- distributed, specialized packages, also referred to as digital tiers. We provide authenticated U.S. TV Everywhere products that are available to certain subscribers and connect viewers through GO applications with live and on- demand access to award-winning shows and series from 10 U.S. networks in the Discovery portfolio: Discovery Channel, TLC, Animal Planet, ID, Science Channel, Velocity, Discovery Family Channel, Destination America, American Heroes Channel ("AHC") and Discovery Life. The Oprah Winfrey Network ("OWN"), a consolidated subsidiary as of November 30, 2017, is currently on the Watch OWN application. During 2017, we achieved incremental increases in U.S. digital platform consumption. We also provide our networks to consumers as part of subscription-based over-the-top services provided by DirectTV Now, Sony Vue and Philo. Advertising revenue is generated across multiple platforms and is based on the price received for available advertising spots and is dependent upon a number of factors including the number of subscribers to our channels, viewership demographics, the popularity of our programming, our ability to sell commercial time over a portfolio of channels and leverage multiple platforms to connect advertisers to target audiences. In the U.S., advertising time is sold in the upfront and scatter markets. In the upfront market, advertisers buy advertising time for upcoming seasons and, by committing to purchase in advance, lock in the advertising rates they will pay for the upcoming year. Many upfront advertising commitments include options whereby advertisers may reduce purchase commitments. In the scatter market, advertisers buy advertising closer to the time when the commercials will be run, which often results in a pricing premium compared to the upfront rates. The mix of upfront and scatter market advertising time sold is based upon the economic conditions at the time that upfront sales take place, impacting the sell-out levels management is willing

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